Bank of England raises interest rates but signals it may have done enough to tame inflation

ITV News Business and Economics Editor Joel Hills reports on the significance of the interest rate hike

This is a pretty sorry situation.

The UK economy is basically flat-lining, higher interest rates have thrown the housing market into reverse and business failures are creeping up.

In different circumstances you would expect the Bank of England to be cutting interest rates but sadly inflation still glows red hot and there are clear signs it is feeding itself domestically.

To bring down domestic inflation the Bank feels compelled to weaken growth.

The result: another muscular interest rate rise of 0.5%  

We’ve had ten interest rates rises now in the space of fourteen months. Bank Rate stands at 4%. 

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Not so long ago the Bank promised that increases in interest rate rises, when they happened, would be “gradual” and “limited”. That guidance proved flawed.

The monthly repayment on the average tracker mortgage has now risen by almost £400 in just over a year. 

More than two million homeowners will be remortgaging this year.

Their cost of living crisis is about to intensify but they can at least feel reassured the Bank is signalling that it may have done enough to tame inflation.

In previous months, the Monetary Policy Committee has warned it may have to act “more forcefully” if prices continued rising. That direction has gone. 

The minutes simply state “further tightening in monetary policy would be required” if “there were to be evidence of more persistent pressure”.

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For what it’s worth, investors are betting Bank Rate will peak around 4.25 later this year.

The tone has changed because the outlook has improved.

The market price of gas and oil has fallen significantly in the last three months, the headline rate of inflation is expected to fall below 8% in the summer and reach the Bank’s 2% target next spring. 

The Bank’s main concern is the labour market. The economy is still awash with vacancies, companies are telling the Bank they intend to hike pay by almost six percent in the months ahead - that is less than many employees would like but much more than the Bank is willing to tolerate.

The Bank still thinks the UK is heading for a recession, albeit a significantly shorter and shallower one than it was forecasting last November.

If the Bank is right, then the economy will start growing again in early 2024 but the recovery, when it comes, will be feeble. Annual growth of 0.25% in 2025 is not going to leave many people feeling better off.

The government has pledged to revive our economic fortunes. It has its work cut out. 

Last week, the chancellor pushed back against what he says is a sense of “declinism” in the UK. Sadly, our prospects in the short-term have declined.

The Bank has temporarily lowered it’s estimate of “potential GDP” to 0.7% for the next few years. This is dismal.

Brexit, Covid and the war in Ukraine have variously damaged productivity, business investment and caused the workforce to shrink. The safe “speed limit” of the UK economy, its ability to grow without generating inflation, has fallen.

Before the Great Financial Crisis, the Bank estimated UK Potential GDP to be 2.5%.

The government, of course, may feel under pressure to explain why our departure from the EU has played a part in the Bank’s decision to downgrade potential output.

What about the Brexit freedoms we hear so much about? If regulatory changes like the chancellor’s Edinburgh Reforms are as transformative as we are told then surely the Bank would be raising its estimate.

In November 2019 the Bank of England calculated Brexit would wipe 3.25% off UK GDP “in the long term”.

It doesn’t appear to have changed its estimate of the size of the “hit” but it does think we are feeling more of it sooner. 

Trade and business investment have been impacted by more than the Bank was expecting.